Pension investments are a seemingly attractive option for Muslims that want a fixed income for life. However, there are certain complications when it comes to determining whether such an investment is halal, based on Islamic Shariah.
From a Shariah perspective, there is nothing wrong with receiving pension benefits as long as the investment is being made in a halal business. However, you should be careful while choosing a pension plan as some of them might not follow Islamic finance principles.
Before stepping into the pension investments domain, it is better to clear any doubts you might have regarding it being halal. For that, we will discuss the Islamic perspective of pension investments so that Muslims around the world can avail this productive investment option without compromising on their religious beliefs.
Are Pension Investments Halal?
In pension plans, a fixed amount of money is deducted from a government employee’s salary which is returned to him in the form of state pension at the time of retirement. It is a unilateral contract in which the state obligates such deductions to provide a defined benefit to its citizens according to a pre-agreed schedule. There is nothing controversial here from the Shariah point of view. However, private pensions are subjected to some uncertainty, and you have to understand their mechanism before going for them.
Pension investments are permitted in Islam if the money is invested in Shariah-compliant business. However, Islam strictly negates the element of uncertainty in mutual contracts, as such contracts are termed defective in Islam. Out of two pension plans available today, the “final salary scheme” falls under a defective contract as it contains an element of gross uncertainty. While “money purchase scheme” is transparent, hence permitted in Islam.
In the final salary scheme, a certain amount is promised at the time of retirement. Still, the employer has to compensate in case of underperformance, giving rise to the dispute and triggering gross uncertainty. Money purchase depends on investment performance. Hence, it is completely fine. Moreover, you invest your share of the money by yourself in money purchase, so the Shariah-compliance element is also ensured.
The final salary is a pot of money kept aside for the employee, invested by the board of trustees on its behalf, and a certain amount of pension is promised to the employee. In underperformance, the employee is legally obliged to meet this deficit so the pot can generate all the pension payments it intended to make. A money purchase scheme as long as invested in permitted (halal) businesses only is termed legitimate from an Islamic point of view.
Is My Workplace Pension Halal?
Workplace investments offer you money from employers’ contributions. Though, it is an uphill battle to know if your workplace investment is halal. Even if we know about the sort of activities to invest in, we have to look into each investment component and work out for assessing what percentage of funds each component part holds to gauge overall Shariah compliance. However, this is not practical.
The most concrete way to ensure the validity of your workplace investment in Islam is to see whether the pension provider is offering authentic Shariah-compliant offers or not. Suppose they invest money in haram activities, such as making alcohol, pork, and interest-based loans. In that case, this is another reason to label such pensions haram, besides the element of Gharar (uncertainty).
Though, this applies only if your contribution to the pension investment plan is voluntary. If this participation is compulsory, as in-state pensions, you are not accountable for the source of the pension amount. Workplace pensions are undoubtedly quite effective in saving money for your retirement life as you essentially get a 20% boost. However, unless you have a Shariah-compliant investment option within the provider’s offerings, there is too much complexity and uncertainty in the workplace pension realm.
Is the National Pension Scheme Halal?
In national pension contributions, a part of employees’ salary is deducted at source at definite rates. Such rates are based on the amount of contribution an employee has been credited with before retirement. Every government employee is obliged to make such contributions. This is a government effort to help their citizens with a lump sum of money that they can use after retirement.
Such pension plans are unilateral undertakings by the government, which means only the government decides these deductions according to a predetermined schedule. These plans obviate the element of riba (interest), so they are permitted in Islam.
The amount deducted from employees’ salaries can be constructed in two ways; if such pensions constitute deferred salary which the state decides to grant to the employee at the time of retirement. This pension is termed “state pension.” If this results from a mutual agreement between the state and the employee, an excess of what is contributed would be termed riba (interest), which is forbidden in Islam. Employees must make such deductions if such contributions do not constitute a deferred salary.
What if What My Workplace Pension Invests in Isn’t Halal?
If the previously mentioned stats were bad, it is worse to know that out of 69.6% of pension-holder Muslim employees, 39.5% of employees did not find an Islamic pension option in their pension provider’s offerings. It means almost 40% of Muslim pension holders take pensions that go against their beliefs due to a lack of alternatives.
Any deduction that is invested in businesses and trade activities engaged in interest-based activities, bribery, gambling, or dealing with alcohol, pork, and other forbidden activities is not halal. Muslims must ensure their employees’ pension contributions are invested in activities that are under Islam. Furthermore, if your employer offers a final salary option only and you have a choice to embrace it or not, you must avoid this form of pension investment.
The final salary pension scheme has a lot of uncertainty and unknown remuneration that goes against the teachings of Islam, and practising Muslims must avert such types of pension investment options. Any contract that has a risk of raising a dispute is termed defective. Pension schemes often go to court and create a dispute, such as in the Philip Green case and other cases that deal with the deficit in pensions.
How Can Muslims Save for Retirement?
What if you have just realised your workplace investment is not halal? Do you still have to waste your hard-earned money on a haram fund? Do you really need to spend your life using tainted means of income? If your occupational investment is not halal and you no longer want to proceed with it, there are still a few options for you. However, they are not ideal because you will not be getting a steady income route for your savings, plus you will lose the employers’ contributions.
Opting out and enjoying the extra money won’t be a good idea if you want to save for retirement. You can conduct your own investment plan with the money that was intended to contribute to pension investment. In Islam, you can also consider a self-invested personal pension (SIPP) as a safe pension option.
If you will invest on your own with that extra amount, syphon some off from your salary manually. Then set up an individual saving account (ISA), either in the form of cash or stocks & shares and keep some specific amount in it every month. In SIPP, deductions are not made from your gross salary, you have to add it yourself from your net pay. You will get 20% of that money credited as a relief. SIPP comes with strict pension rules, for instance, you cannot withdraw money before the state pension specified period.
For more on this topic, read my recent post by clicking on the following link: What is a comfortable retirement income in the UK?
Is a 401K Permissible in Islam in the US?
Companies offer 401k retirement savings accounts to their employees with some tax returns. A small amount of money from employees’ paychecks is transferred to their 401k accounts. The remaining amount is taxed less. The amount in the 401k account grows free of tax.
But unfortunately, 401k accounts are not halal unless you decide to alter the investment plan by yourself. Most of the 401k investments in the US go to default funds that often have interest-based investments such as bonds or non-Shariah-compliant companies.
Alternatively, you can make your own 401k plan to make your contribution to investments. Moreover, you can contribute some amount to Islamic-approved mutual funds after receiving your salary.
Do Most Muslims Have a Pension?
Muslims attempt to avoid such activities that have an element of uncertainty. Investment options are usually not transparent; Muslims find it difficult to understand their work and cannot label them halal or haram.
A survey by IFG found that 78.1% of Muslims do not opt for retirement explicitly due to sharia-compliance concerns, which means they are losing £13 billion in pensions over a generation. The reason behind this loss is either the lack of information among Muslims to make their minds up if the pension is Shariah-compliant or they cannot find halal options.
Out of almost 3.4 million Muslims in the UK, 680,000 Muslims are in occupation, and 30% of these Muslims do not have pensions. This might be due to a lack of awareness among Muslims, as less data is available on this concept.
Every pension provider must add an Islamic option to its offerings. Moreover, Muslims must be provided with information and awareness to assess whether investment option is permitted in Islam.
Final Thoughts
Pension investments have great potential to help sustain your lives after retirement. However, the permissibility of such investment options in Islam must be ensured by Muslims before opting for them. Money purchase investment schemes are permitted in Islam due to reduced gross uncertainty and known remunerations. However, the investments must be made in Shariah-compliant business and trade options.
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As always, please remember I am an Accountant, not your Accountant. In this post (and all of my others) I share information and often give anecdotes about what has worked well for me. However, I do not know your financial situation and I do not offer individual financial advice. If you are unsure of a particular financial subject, please hire a qualified financial advisor to guide you.
This article has been written by Luke Girling, ACA – a qualified Accountant and personal finance enthusiast in the UK. Please visit my ‘About‘ page for more information. To verify my ACA credentials – please search for my name at the ICAEW member finder. Please comment below or contact me here to get in touch with questions or ideas for future posts.